One of the features of the last few years has been the boom in car finance in the UK. This has led to a subsequent rise in car sales leading to something of a boom for the UK automotive sector. the rate of annual UK car registrations dipped to below 2 million in 2011 and much of 2012 but then accelerated such that the SMMT ( Society of Motor Manufacturers and Traders) reported this in January last year.
UK new car registrations for 2015 beat 2.6 million units for the first time, sealing four years of consecutive growth. The market has posted increases in all bar one of the past 46 months ………Overall, the market rose 6.3% in 2015 to 2,633,503 units – exceeding forecast and outperforming the last record year in 2003 when 2,579,050 new cars left the UK’s showrooms.
So volumes surged as we note the official explanation of why.
Buyers took advantage of attractive finance deals and low inflation to secure some of the most innovative, high tech and fuel efficient vehicles ever produced.
The “attractive finance deals” attracts my attention as it feeds into one of my themes. This is that the Bank of England loosened up credit availability with its Funding for Lending Scheme in the summer of 2013. This flowed into the mortgage market but increasingly looks as if it flowed into the car finance market as well leading to what are described as “attractive finance deals”. This was added to by the Term Funding Scheme ( £80.4 billion and rising) of last August when the Bank of England wanted a “Sledgehammer” of support for lending. We know from past experience that such actions lead to the funds going to all sorts of places that no doubt will be officially denied, or disintermediation. But the car finance industry has exploded to now be 86% of the new car market. Of course the Bank will also describe itself as being “vigilant” about credit risks.
This is the blog of the staff of the Bank of England rather than the London Underground station to which I commuted for quite a few years. They point out that the car market is now slowing.
Private demand for new cars slowed in 2016 (Chart 2). New car registrations spiked higher in 2017 Q1 — mostly due to changes in vehicle excise duty — but fell back sharply thereafter. The Society for Motor Manufacturers and Traders (SMMT) forecasts registrations declining by 2½% in 2017 and by a further 4% in 2018.
I know that this is being described as a consequence of the EU leave vote but whilst the fall in real wages may have added to it a fall was on its way for a saturated market. How many cars can we all drive on what are often very congested roads? Also the bit about “high-tech” I quoted from the SMMT last January has not worn the passage of time well. Although to be fair the emissions cheating software on many diesels was indeed high-tech. The consequence of that episode has also affected the market as I am sure some are waiting to see if the diesel scrappage scheme that was promised actually appears.
So we had a monetary effort to create a Keynesian effect which is that what was badged as “credit easing” did what it says on the tin. Car manufacturers and others used it to offer loans and contracts which shifted car demand forwards. But the catch is what happened next? The future is supposed to be ready for us to pick up that poor battered can which was kicked forwards but increasingly it does not turn out like that.
What about the finance market?
According to the Bank of England it has responded and below is one of the changes.
Providers are increasingly retailing contracts where consumers have no option to purchase the car at the end. This avoids some risks associated with voluntary terminations, but it creates new risks around resale value.
Are they avoiding a problem now being creating one at the end of the contract? Anyway that issue is added to by the familiar response of a credit market to signs of trouble which can be described as “extend and pretend”
finance providers have responded by lengthening loan terms and increasing balloon payments rather than upping monthly repayments.
Actually there are a variety of efforts going on in addition to lengthening the loan term.
Manufacturers typically set the GMFV ( Guaranteed Minimum Future Value) at around 90% of the projected second-hand value at the end of the contract, in order to build a safety margin into their calculations. Tweaking the proportion can have a material impact on the cost of car finance. Switching the GMFV from 90% to 95% would likely reduce the consumer’s monthly payment.
Reducing the safety margin at the first sign of trouble is of course covered by one of the Nutty Boys biggest hits.
Madness, they call it Madness
Also there is a switch to PCH or Personal Contract Hire finance where the consumer does not have the option to buy the car. This is presumably to avoid what for them will be a worrying development.
So-called voluntary terminations are increasing, and usually result in losses to the finance houses.
However this comes with quite a price.
Greater use of PCH has certain risks attached for car finance houses. The primary risk inherent in PCP finance (ie the car’s uncertain market value when returned at the end of the contract) is at least as great under PCH. And a business model of increasingly relying on volatile and lower-margin wholesale markets to sell cars adds to the risk.
Oh and when all else fails there is of course ouvert price cuts.
Manufacturers often vary the amount of cash support to car dealers in order to meet sales targets — sometimes referred to as variable marketing programmes….. Our intelligence suggests that dealership incentives have increased over the past year.
So my financial lexicon for these times needs to add “cash support” and “dealership incentives” to its definition of price cuts. As it happens an advert for SEAT came on the radio as I was typing this I looked up the details. This is for an Ibiza SE.
One year’s Free Insurance (from 18 yrs)^
- £1,500 deposit contribution**
- 5.9% APR Representative**
- Plus an extra £500 off when you take a test drive*
It is hard not to look across the Atlantic and see increasingly worrying signs about the car loans market. There are differences as for example the falling car prices seen in the consumer inflation data are not really being repeated in the UK so far. I checked the July data earlier this week and whilst used car prices fell by 1.1% new car prices rose by 1.3% although of course we wonder if the new offers are reflected in that? However the move towards “extend and pretend” and the use of the word “innovative” is troubling as we know where that mostly ends up. Or if you prefer here is it via the Bank of England private coded language.
That is partly because car manufacturers and their finance houses are increasingly stimulating private demand by offering cheaper (and new) forms of car finance. As amounts of consumer credit increase, so do the risks to the finance providers. Most car finance is provided by non-banks, which are not subject to prudential regulation in the way that banks are. These developments make the industry increasingly vulnerable to shocks.
My deepest sympathies go out to those caught up in the terrorist attacks in and around Barcelona yesterday.